More Euro worries
July 15th, 2011
The UK may be mesmerised by the Murdoch saga, but the markets are spooked by the everyday story of Euro folk. This week saw the misery spread to Italy.
In a way that’s strange. Italy has held a high level of debt for many years. Her deficit is under better control than many. For months Italy had been on the safer list, with people fearing contagion leaping from Portugal and Greece to Spain. Suddenly the story became the political difficulties in Italy, as the government proposed another deficit cutting austerity package. Attention was turned to Italian banks, with worries about how strong some of them are. Calculations were done about what happens to Italian state and bank figures if the costs for Italian borrowing rise.
Sure enough, on cue, the markets made the costs rise. Towards the end of the week the Italian state had to borrow to show it still could. 5 year money cost it 4.93%, up 103 basis points on a month ago, whilst fifteen year money came at 5.9%. These are high figures by comparison to recent levels or to the German standard. Replacing more of Italy’s maturing state debt at these or higher levels will place further strain on the Italian budget.
Today markets await the new bank stress tests. Last year’s tests were soon dismissed by markets and commentators as too easy. Irish banks passed, then promptly got into difficulties. This year’s stress tests will be a bit tougher, and will remind investors that many EU banks hold government debt as a so called safe asset. Some investors now apply a hair cut to some state debt, worrying about its current market value and in some cases whether it will be repaid in full with full interest.
Meanwhile, the EU politicians remain divided over what to do. There is a growing voice for a more dynamic move to a federal government solution. Politicians, advisers and commentators are dusting down schemes for an EU Finance Minister, strict budget controls over Euro members, larger transfer payments around the Euro union and some common borrowing on behalf of the Euro area as a whole with guarantees from all the member states. There is talk of a transfer union and even of a fiscal union.
The big question is how far will Germany go, as the most successful large economy in the zone and the one who would have to pay more of the bills. Germany herself is keen to keep the European Central Bank on a firm course to control inflation. The weaker members of the zone would like the Bank to buy in more unloved bonds, and would like the Bank to print more cash. That could be used to get the exchange rate down a bit so they could compete more easily. It could also be used to shore up banks around the area that are still weak.
Markets want to believe they will once again muddle through. The longer the politicians leave fixing the problems, the worse the crisis will be when it erupts again.
